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This week's Carnival of the Capitalists is hosted by the Coyote Blog. We're big fans of the Coyote here at Political Calculations, particularly his ingeneous supply of technology! Speaking of which, be sure to visit the Coyote's sponsor, as it looks like they've reconciled their past differences....

Ever since economist John Kenneth Galbraith coined the term "conventional wisdom" in his book The Affluent Society, a lot of the public's collective wisdom has been directed toward how changes in the status quo will affect the future of the U.S. economy. One of the newly held common beliefs is that the U.S. stock market will take off like a rocket should the option to add a Personal Retirement Account (PRA) option to Social Security's retirement benefit program be adopted.

The thinking goes something like this:

There's a relatively fixed supply of stocks.

Money invested through PRAs will increase the demand for these stocks.

Since the demand for stocks will increase, and the supply of stocks will remain roughly the same, stock prices (and the stock market) will go up.

Makes perfect sense, right? It's the Law of Supply and Demand. It has even been suggested that you can train a parrot to be an economist by teaching them to repeat the phrase! But is it really that simple when it comes to Social Security reform and the stock market? Let's look at both the Supply and the Demand sides of the equation.

The Supply of Stocks

Unlike the public's perception that the stock market is a pretty static place, in reality, the stock market is a *very* dynamic environment. Every day, a new supply of stock is issued by both new and existing publicly traded companies, while other stocks previously issued into the market are removed through various processes of buy-backs, mergers and acquisitions, bankruptcies, and so on. The supply of stocks in the stock market constantly grows or shrinks over the net exchange. Over the long term, the market is efficient at matching the available supply of stock to the demand for it. In the short term however, it would be logical to expect a bump up in stock prices, which would last for as long as it takes the market to adapt by drawing more companies into the market to compete for this increased supply of capital.

The Demand for Stocks

The demand for stocks is the trickier of the two sides of the equation to take into account. While the PRA option would allow people who otherwise would not be able to own shares of publicly traded companies to do so, when it comes to measuring what the change in demand for stocks will be, the real question comes down to what will the people who already regularly invest in stocks through their 401(k) plan, 403(b) plan, Individual Retirement Accounts or on their own do?

The answer hinges on the "whys" of the reasons individuals invest for their retirement through the stock market. For older people eligible for the proposed Personal Retirement Account option, their PRA contributions will likely represent a means of supplementing income from their other retirement plans. I suspect that those who fit this description and who select the PRA option will likely provide much of the increased short term demand for stocks, but their influence on the overall level of the market will be limited due to the proposed introductory cap on contributions (see this 45K PDF document) that will hold down the amount of capital coming into the market in the program's early years.

For younger people already investing in stocks through their retirement plans, there is another conventional wisdom, backed up by projections from the Social Security administration, that the retirement benefits that will come to them from the current program will be sharply reduced compared to those received by older generations. They are investing toward their retirement now to make up for the expected future shortfall.

Here, I believe the key issue of the future will involve trust. Once the PRA option is established, and its performance able to be assessed from real-life data, the younger generations participating in the program may choose to reduce their contributions to their other retirement plans since they will be able to reasonably determine if they will be able to rely on the returns from their PRA. If they assess that they can rely on their PRA returns, they will likely redirect some of their current level of retirement-focused investing into other areas, allowing them the advantage of being able pursue other opportunities with their earnings, which would mean that value of the stock market is unlikely to be directly affected in the long term from the proposed reform.

Final Thoughts and Questions

It remains to be seen if there will be an option for individuals to apply a portion of their Social Security taxes toward Personal Retirement Accounts. My thinking is that should the PRA option become available, it will only have a direct effect upon the stock market in the short term, and not in the long term. The question then becomes will it have an indirect effect? What will happen if the PRA option becomes trusted enough to allow younger generations to have the confidence to redirect their other earnings away from investing to support their future retirement? Will their redirected earnings provide the basis for greater economic growth that will in turn support greater growth in the value of the stock market? Only time will tell.

One of the questions that frequently comes up in basic investing scenarios is "How long will it take to reach my investing goal?" Political CalculationsTM has finally found enough time to crank out this pretty simple tool, which will help you find out how much time you will need to reach your target value in a simple investment. Starting with the amount you plan to invest, enter the annual interest rate and the compounding rate of the investment, then enter the future value that you hope to achieve. Click the "Calculate" button and the calculator will do all the rest. Here's hoping your goal is in easy reach!

I just received word that content from Political CalculationsTM will now be syndicated through Bill Parke's Economics Roundtable. For those not already familiar with the Roundtable, the site provides a one-stop shop for catching up on economics posts around the blogosphere. It's especially invaluable for keeping track of contributions from blogs that, like Political Calculations, do not post on a daily basis. Highly recommended!

This news also means that I'll be addressing a number of behind-the-scenes technical issues to better support the content that will be appearing at the Economics Roundtable. As a result, new contributions will be light this week, as I get some recently discovered Blogger/Blogspot glitches unglitched.

It was always bound to happen, and now Senator Harry Reid and Senator Charles Schumer have unveiled their version of a Social Security versus Personal Retirement Account comparison calculator. I've been contributing to discussions of the validity of the Senators' math in other forums, so I won't re-address my points here at Political CalculationsTM. I prefer to focus on my own math, and others are doing an excellent job in taking apart the cherry-picked assumptions behind the senatorial Democrats version, in some cases picking up things I had missed in my own analysis. Here is the short list of sites to pick up on my thoughts and those of others:

In news from MSM sources, Robert Robb of the Arizona Republicnotes that "a cottage industry has sprung up calculating what sort of returns personal accounts would have to generate for workers to be ahead." He continues, observing:

But these are based on reductions in traditional benefits Bush hasn't specified, compared to a current Social Security system that somehow gets miraculously fixed.

If I'm not mistaken, he is referring to the Reid/Schumer comparison calculator - I wonder if this recognition was dropped for space limitations for the print edition. In any case, you would think the effort put forth by a major political party wouldn't be described as being the product of a "cottage industry."

I'll continue updating this post as more insights are added around the blogosphere.

Update: Apologies for not greeting all you Carnival of the Capitalists readers earlier, but we try to take advantage of the long holiday weekends here at Political CalculationsTM!

Since launching the newest version of the Social Security vs. Personal Retirement Accounts comparison calculator that takes the President's proposal into account, a lot of people across the blogosphere are asking a lot of the same good questions regarding many of the details going into the assumptions behind the calculator. It quickly became clear to me that instead of responding in each forum independently, the best approach would be to write up the answers to the most frequently asked questions as a stand-alone post, and to refer back to it as necessary. So, without further adieu, here are the answers that many of you are craving:

There are aspects to Social Security regarding disability benefits and widow and orphan benefits that need to be incorporated into any reform. Did you take these into account in your research and development of your tool?

Currently, the taxes that your employer and/or you (it's "or" if you're self-employed) pay into Social Security are divided between two programs after administrative expenses are taken out. Of the 12.4% of your income that taxed toward Social Security, an amount roughly equal to 10.6% of your income goes to the Old Age and Survivor Insurance (OASI) program, which is the part that covers pension and survivor benefits, and the remaining 1.8% (approximately) goes into the Disability Insurance (DI) program. Since the President's plan would only affect the OASI program, those receiving disability benefits from the DI program will be unaffected by the proposed reforms. As a result, the calculator only considers the OASI contributions.

The question of how those receiving survivor benefits (widows, orphans) is not one I can really answer. There are a great many variables to take into account, such as how much the survivors would receive from the survivor's insurance program when they would outright inherit the amount in their lost breadwinner's PRA. Because survivor benefits are paid directly from the "pay-as-you-go" portion of the OASI trust fund, I would suspect that those receiving these benefits would be relatively unaffected since the President's program caps individual contributions to PRAs at 4% of their income (meaning that an amount equal to 6.6% of their income would be passed through the traditional Social Security OASI program). In the program's early years, even more funding would be passed through to the traditional OASI program, given that there will be a lower introductory cap on individual contributions that gradually becomes phased out over a long period of time.

For more information about how Social Security taxes are divided between the OASI and DI trust funds, the government's Railroad Retirement Board has a neat 266 KB PDF document that shows the history of these tax rates dating back to the inception of the Social Security program.

Why is SSI is not accounted for in the rate-of-return estimates?

The Supplemental Security Income (SSI) program, which provides monthly benefits to people who are age 65 or older, or are blind or disabled, and have limited income and financial resources, is not accounted for in the calculator's rate of return estimates since no Social Security taxes go toward paying these benefits. SSI benefits are instead financed directly from the U.S. Treasury's general fund, which is where all the other tax revenue collected by the federal government is pooled. As a result, SSI benefits have no bearing on the amount of money you would receive in retirement from the Social Security program, and SSI is therefore not accounted for by the comparison calculator.

There is some common confusion about these details since the Social Security Administration (SSA) is responsible for managing the SSI program. However, as noted before, no Social Security taxes other than those for the agency's administrative expenses are applied toward these benefits. For more information, see the Social Security booklet Understanding SSI.

Are cost of living adjustments taken into account?

No. The reason is that this kind of adjustment is not necessary for the purpose of comparing the equivalent investment returns. Since cost of living adjustments are based on the rate of inflation, the associated percentage increases you would see in your equivalent investment returns from Social Security would also be reflected in increased rates of return from your PRA investment. What this does mean, and I have revised the calculator to indicate this fact, is that the rate of return you enter is the inflation-adjusted rate of return you would anticipate from your investment.

How does the calculator's rate of return for Social Security compare to the official projections?

Relatively well, but with certain things you should take into account in assessing how useful the calculator is to you. The calculator's Social Security rate of return is based on numbers published in 2000 (the details behind how I developed the formula used are available for your review). I think we can be pretty sure that the official projections are backed by much more data, including more recent data.

Compared to the offical projections from the SSA, the formula I developed overstates the rates of return in the years leading up to the mid-2020s, and understates the rates of return in the years following the mid-2020s. What this means is that up until the mid-2020s, the calculator will return investment values for SS Only that are higher that what the official projections estimate. After the mid-2020s, the calculator will return values that are lower that what the official projections predict. I am presently working on a new version of the tool that will allow you to choose between the various projections that have been made regarding the future rates of return from Social Security, so you'll be able to go with the numbers you find most plausible.

Does the calculator use realistic growth estimates?

That depends on you. It's inherent in the value you enter for your PRA's rate of return.

Besides just wanting to see which would be better, my goal in developing the Social Security vs Personal Retirement Account comparison calculator has been to provide its users with an unprecedented amount of transparency in being able to see the assumptions behind how the calculator determines its results. I welcome all constructive feedback.

Their departures also share another common thread. The truth in each situation, as we have learned it to be, was never, and has still not yet been fully addressed by the senior-most leadership of the organizations which employed them. Of all the situations that led to the firings, resignations and accelerated "retirements" of Jordan, Raines, Rather and Mapes, only CBS has performed a semi-independent review analyzing the circumstances that led to the premature career terminations of its employees. And yet, the senior executives of CBS' parent company Viacom, like their counterparts at the New York Times Company and CNN's parent company Time Warner, have never fully focused their attention on the environments that allowed their employees to pursue their agendas unchecked on their watch. At best, they have only added layers to their companies' internal processes, but have not yet dealt with the core issue leading to their lapses - the "groupthink" that refused to challenge the direction their employees were taking.

In all cases, problems related to the judgment of Jordan, Raines, Rather and Mapes were clearly laid out years before they arrived at the events that led to their disgrace and fall. Jordan had made numerous public comments indicating his bias against the militaries of the U.S. and Israel. Dan Rather's ideologically-basedtransgressions are almost legendary. Mary Mapes issues should have been addressed by those to whom she reported. Howell Raines' tyrannical stewardship of the New York Times eventually resulted in the newspaper's staff rebelling before his missives, but only after he became vulnerable as a result of Jayson Blair's frauds.

And still, even in the discreditation of each of the institutions of the New York Times, CBS News and CNN, the environment that tolerated the "misleadership" of each of these people has not been addressed. They were never challenged by those around them along the way to their disgrace. They were instead accepted, admired, and lauded. They were members of the club, and they still are. At least until the institutions of the New York Times, CBS and CNN change to finally expel the lingering corrosion of their internal culture's influence.

Afterthoughts: Added February 17, 2005.

It occurred to me that many of the disasterous decisions that led each of the otherwise talented and smart individuals above to their premature career terminations could very well be appended to Sydney Finkelstein's Why Smart Executives Fail. I highly recommend this book. My great hope is that Finkelstein already has a second edition in the works to incorporate post-mortems for the affairs detailed above and to update the book's case studies. I would be particularly interested to see how he would place former Boeing CEO Phil Condit's management of the airplane maker, given what was learned about his stewardship after the book's publication. (Finkelstein cites Condit as a positive example in his section on how companies can build a "culture of openness.")

Editor's Note: The final sentence of the main article preceding the Afterthoughts originally read: "At least until the institutions of the New York Times, CBS and CNN change to finally expel the lingering corrosion of their influence." The change was made to clarify what influence is at work.

Welcome Carnival of the Capitalists, which for those arriving here from elsewhere is being hosted this week at Weekend Pundit. And before you ask, yes, the calculator is different from the last go-around....

P.P.S.: Answers to frequently asked questions about the calculator are now available!

Previously, Political CalculationsTM looked at whether or not the President's proposed Personal Retirement Accounts would be a good option for providing retirement benefits for America's working population, and built a tool to find out. Of course, that was before we learned more about just what the White House has in mind (available online as a 45K PDF document.) Armed with the President's plan, I've built the next generation Social Security (SS) versus Personal Retirement Account (PRA) performance calculator, Political Calculations' latest contribution to helping you answer the immortal question: "Which is better for you?"

The calculator below determines what the future value that your combined Social Security and PRA investments would be at the point at which you become eligible to receive full Social Security pension benefits, as if your Social Security taxes were really being set aside in a special account just for you. The tool takes into account the PRA's cap on initial contributions and when you become eligible to participate. The tool does not however take the annual income cap ($90,000 in 2005) for Social Security taxes into account - not because it might be raised as part of a massive tax increase, as some have proposed, but because it's a non-factor for over 80% of those paying Social Security taxes (see Page 2 of this 791K PDF document for recent salary data from the U.S. Census).

From the previous edition, users have reported that the most difficult information to find is the amount of Social Security taxes that you have already paid into the program. If you're age 25 or older, this information may be obtained from Page 3 of the Social Security statement mailed to you each year. If you're under 25, you may request your statement directly from the agency, or backtrack over your old paystubs and/or your previous years' tax returns to find the amount of Social Security taxes that you've already paid. Be sure to add the amount of taxes that you paid and the amount of taxes that your employer paid on your behalf together for the correct amount of Social Security taxes to enter in the field.

With all that said, the only guidance I'll provide to help you decide what a realistic inflation-adjusted rate of return you might expect to receive from the proposed typical investment options (listed here in a 31K PDF document) is to also point to my earlier tool for determining historical best and worst case investment returns from the stock market. And now, here's where your part begins - just enter the indicated information in the Individual Data and PRA Contribution portions of the tool below to see how the President's plan may affect you.

Individual Data

Input Data

Values

Birth Year

Current Annual Pay ($USD)

Years Already Worked

Your Average Annual Raise (%)

Taxes Already Paid Into Social Security ($USD)

PRA Contribution Data

Input Data

Values

Maximum Percentage of Annual Salary (%)

Average Investment Rate of Return (%)

Defined Years of Eligibility

Year Eligible to Retire with Full Benefits from Social Security

Year Eligible to Start Investing in a PRA

Projected Investment Contributions

Estimated Results

Values

Total Lifetime Social Security Taxes ($USD)

Portion of SS Taxes Dedicated to Pension Benefits ($USD)

PRA Contributions ($USD)

Investment Value at Year of Scheduled Retirement

Projected Results

Investment Values

Difference from SS Only

Social Security Only ($USD)

Your PRA and Social Security ($USD)

The results above should indicate whether or not the President's Personal Retirement Accounts are a better option for you over the straight Social Security option. Also keep in mind that your participation in the PRA option is *voluntary*, and the program will be set up to continue devoting 100% of your Social Security taxes to the regular Social Security program unless you specifically enroll in the PRA option.

Want More Information?

Explanations are available for how the calculator determines the inflation-adjusted, annualized rates of return for your Social Security "investment", the best and worst case investment returns to expect from your PRA account (also linked above) and answers to Frequently Asked Questions. The default value for your average annual raise is taken as being 1.0% ahead of the historic rate of inflation in the U.S. and the default value for your PRA rate of return is taken as being between 6.0% and 7.0%, which coincides with the average inflation-adjusted long-term rate of return from the stock market.

It occurred to me that I should probably fill in some missing pieces related to investing here at Political CalculationsTM. With that in mind, I've recently found it necessary to extract the annual rate of return from an investment, giving only its starting balance, ending balance, and time held (assuming annual compounding.) It's just the kind of thing you need to measure the long-term average performance of your investment, and here it is!

Investment Information

Input Data

Values

Starting Balance ($USD)

Ending Balance ($USD)

Time Held (Years)

Average Rate of Return

Calculated Results

Values

Annualized Rate (%)

If you're a real glutton for punishment, try replacing the numbers above with the appropriate data for your starting salary, current salary and the amount of time you've been working. (Editor's note: Political Calculations cannot be held accountable for damage to your computer from spitting out your beverage on it....)

What would happen if you invested $1,500 annually for 40 years at a conservative 6% rate of return? Your ending balance would be $246,072, $167,372 MORE than the current system (and eight times more than the Post analysis would lead you to believe).

But what if you want to invest a different amount of money? What if you want to see what a different rate of return might net you? Political CalculationsTM is here for you with the tools to help chart your financial future!

In the table below, enter the indicated information to find out what the future value of your investment will be. One neat feature provided below allows you to account for increases in the amount you regularly deposit into your investment (the rate of escalation). This feature is particularly handy if the amount you regularly deposit is linked to your paycheck, and you receive annual raises!

When you're finished, click the "Calculate" button to see your results.

The latest storm sweeping the blogosphere centers on CNN's
Eason Jordan's claims that the U.S. military is targeting members of the media for assassination:

During one of the discussions about the number of journalists killed in the Iraq War, Eason Jordan asserted that he knew of 12 journalists who had not only been killed by US troops in Iraq, but they had in fact been targeted. He repeated the assertion a few times, which seemed to win favor in parts of the audience (the anti-US crowd) and cause great strain on others.

Checking the Claims

Checking Eason Jordan's claims is fairly easy. The World Association of Newspapers maintains a list of media employees killed in the course of performing their jobs. The following
table summarizes WAN's data related to media employee deaths in 2003 and 2004, and isolates those deaths occuring in Iraq:

Attributing Responsibility

The following summary of media employee deaths in Iraq that may be attributed to the U.S. military is excerpted from WAN's reports (linked in the above table) and has been edited for clarity. Other deaths reported by WAN may be classified as being accidental or the result of insurgent/terrorist activities.

Mazen al-Tumeizi, September 12, 2004

Mazen al-Tumeizi, a reporter for Al-Arabiya television was killed in Baghdad on 12 September after a U.S. helicopter reportedly fired missiles and machine guns to destroy a disabled American vehicle. Video aired by al-Arabiya showed al-Tumeizi was preparing a report nearby when an explosion behind him caused him to double over and scream, "I'm dying, I'm dying." According to reports, fighting broke out on Haifa Street in the centre of Baghdad around dawn, when a U.S. armoured vehicle caught fire and its four crew members were evacuated. As a crowd gathered, one or more U.S. helicopters opened fire.

Mahmoud Hamid Abbas, August 15, 2004

Mahmoud Hamid Abbas, an Iraqi cameraman working for the German television station Zweites Deutsches Fernsehen (ZDF) was killed on 15 August in Fallujah. The television station reported that Abbas had called earlier in the day to say he
had filmed the bombardment of a house in Fallujah by U.S. forces and that he would be returning to Baghdad. Abbas reportedly called the station back a half hour later to say an attack was under way, before the phone line went dead. ZDF reportedly learned of his death the next day after Abbas' body was brought to a Fallujah mosque. The details surrounding the cameraman's death remain unclear.

Assad Kadhem, April 19, 2004

Assad Kadhem was killed by US military fire on 19 April while filming an attack on a US base in the central Iraqi city of Samara, north of Baghdad. The journalist, an Iraqi national, worked for the coalition-funded television channel Al-Iraqiya TV. His driver was also killed in the assault. The precise circumstances of the incident are unclear.

Burhan Mohamed Mazhour, March 26, 2004

Burhan Mohamed Mazhour was killed in the city of Fallujah on 26 March, following a firefight that reportedly occurred as US Marines were conducting house-to-house searches in the city. Mazhour, a freelancer for the American television station ABC, was standing among a group of working journalists when U.S. troops reportedly fired in their direction. Mazhour was struck in the head by a single bullet and later died in a hospital.

Ali al-Khatib, March 19, 2004

Ali al-Khatib died in hospital on 19 March from injuries sustained after being shot near a US military checkpoint in Baghdad the previous day. The reporter, who worked with the United Arab Emirates-based news channel Al-Arabiyya, was part of a four-man news team that had gone that evening to cover the aftermath of a rocket attack against the Burj al-Hayat Hotel. The incident reportedly occurred after a car accidentally crashed into a barrier near the checkpoint. According to a member of the tv team, shots were fired from the direction of the US troops.

Ali Abdel Aziz, March 18, 2004

Ali Abdel Aziz was shot near a US military checkpoint in Baghdad on 18 March. The cameraman, who worked for the United Arab Emirates-based news channel Al-Arabiyya, was part of a four-man news team that had gone that evening to cover the aftermath of a rocket attack on the Burj al-Hayat Hotel. The incident reportedly occurred after a car accidentally crashed into a barrier near the checkpoint. According to a member of the tv team, shots were fired from the direction of the US troops.

Mazen Dana, August 17, 2003

The 32 year-old Reuters television cameraman was killed by machine gun fire from a U.S tank while filming outside an Iraqi prison. According to Dana's soundman, the Palestinian cameraman had asked for and received permission from U.S. troops in the area to film the prison, located in Abou Ghraib, outside Baghdad. U.S. officials have said that the troops mistook the journalist's camera for a rocket-propelled grenade launcher.

Taras Protsyuk and Jose Couso, April 8, 2003

Taras Protsyuk, a Reuters cameraman, and Jose Couso, a Telecinco cameraman, died after the hotel where they were staying was hit by a US tank shell. The shell hit the 15th floor of the Palestine hotel which lodges many foreign journalists in Baghdad. Both Mr Protsyuk, of the Ukraine, and Mr Couso, of Spain, died in hospital. There are conflicting reports about the nature of the shelling. US military officials claim one of their tanks had fired on the hotel in response to incoming sniper and rocket fire. Other journalists in the building at the time of the shelling, have reportedly claimed to have heard no fire coming from the hotel. Three other media workers sustained non-fatal wounds in the incident.

Tareq Ayoub, April 8, 2003

Al-Jazeera correspondent Tareq Ayoub died when the al-Jazeera offices were hit by two American-fired missiles. A cameraman for the television station was also injured by the blast, which virtually decimated the station's offices. Mr. Ayoub, a Jordanian national, was the station's permanent correspondent in Amman, and was sent to Baghdad when the war broke out. The US military said the bombing was a mistake. Al Jazeera had reportedly provided explicit details of the location of the office to the Pentagon, and had also clearly demarcated the building by hanging a large banner outside with the word "TV" inscribed on it. Abu Dhabi television reported its Baghdad bureau as having also been hit by US bombing.

Analyzing 11 Deaths in 9 Incidents

In analyzing the reported circumstances above, the only clear patterns that appear in the deaths of the media employees listed are that they died while the U.S. military was either actively prosecuting the war against Saddam Hussein's regime, responding to crisis events caused by insurgent/terrorist activity, or were outright in error. There is no legitimate basis for claims that media employees have been targeted for assassination by the U.S. military.

CNN's Fallen Employees

Of special note in this discussion are CNN's fallen employees, translator/producer Duraid Isa Mohammed and driver Yasser Khatab, who were killed in a
January 27, 2004 incident. WAN notes:

Duraid Isa Mohammed was killed in an ambush outside of Baghdad on 27 January, when the convoy with which he was travelling came under fire by unidentified assailants. The Iraqi producer, who was working for CNN at the time of his death, was heading toward the capital when a vehicle reportedly approached the two-car convoy from behind, and a single gunman opened fire.

Considering the risks that journalists covering war zones face, it is only all the more repulsive that Eason Jordan would sully their profession with his unfounded utterances. Honest journalists deserve better, and CNN's employees especially deserve new leadership who will respect the mission of journalists in reporting the world that is. Until Eason Jordan is no longer employed by CNN, CNN's credibility must be accounted among its fallen.

In arguing against President Bush's proposed Personal (or Private) Retirement Accounts (PRAs), New York Times' columnist Paul Krugman completely misses the point about why PRAs will be necessary for the majority of today's working population in the United States in his February 1, 2005 column Many Unhappy Returns (Free, but registration required.)

First, let's deal with the crux of Krugman's argument. He states that:

Schemes for Social Security privatization, like the one described in the 2004 Economic Report of the President, invariably assume that investing in stocks will yield a high annual rate of return, 6.5 or 7 percent after inflation, for at least the next 75 years. Without that assumption, these schemes can't deliver on their promises. Yet a rate of return that high is mathematically impossible unless the economy grows much faster than anyone is now expecting. (Emphasis mine.)

Krugman continues arguing his position by looking at the rate of economic growth he believes will be necessary to support these post-inflation stock market returns:

The Social Security projections that say the trust fund will be exhausted by 2042 assume that economic growth will slow as baby boomers leave the work force. The actuaries predict that economic growth, which averaged 3.4 percent per year over the last 75 years, will average only 1.9 percent over the next 75 years.

In the long run, profits grow at the same rate as the economy. So to get that 6.5 percent rate of return, stock prices would have to keep rising faster than profits, decade after decade.

Krugman then brings up the stock market's collective price-to-earnings ratio (P/E Ratio), which is a measure of how much stocks cost for every dollar of profit that the companies behind the stocks generate. He correctly notes that, historically, the stock market's long-term P/E Ratio is 14 (meaning that stocks cost $14 for every $1 in profit they generate) and that the current stock market P/E ratio is 20. He then proceeds to wonder what P/E Ratio would be required to support a 6.5% rate of return in a PRA.

"by 2050, the price-earnings ratio would have to rise to about 70. By 2060, it would have to be more than 100."

Given his assumptions, this would seem to be a good point - a sustained stock market P/E Ratio of 70 or 100 is unlikely. The problem though is that he ignores history, and his own data! Somehow, over the past 200 plus years, the stock market has averaged a post-inflation rate of return of 7.0%, and since 1926, has averaged a rate of return of 7.4%, despite the 3.4% average annual rate of economic growth that Krugman has already noted. We should also note that this rate of return was generated despite the stock market having a long-term P/E Ratio of 14!

At the very least, this outcome would suggest that there are more factors to take into account in projecting stock market returns than just the market's overall P/E Ratio. While the stock market's past performance does not guarantee its future rate of return, should the post-inflation long-term rate of economic growth slow to just 1.9%, going back to the data Krugman uses to support his position, it would seem logical that the stock market long-term rate of growth would also slow, but remain positive.

This is the crucial point Krugman misses. Inflation-adjusted average individual rates of return from Social Security will become negative as the program becomes cash flow negative, currently expected to happen in 2018, and the accumulated trust fund is depleted, currently expected to happen by 2042. No matter how you slice the long-term rate of return from the stock market, and the best and worst case returns you could reasonably expect, it will still outpace the long-term rate of return from an unchanged Social Security program!

"any growth projection that would permit the stock returns the privatizers need to make their schemes work would put Social Security solidly in the black."

In essence, his point is that if economic growth is greater than projected, it will not be necessary to reform Social Security since this growth will be enough to sustain the program. Of course, he ignores that PRAs would be a far superior option for individuals with the same economic forecast.

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